Japan: Further monetary easing possible in October

The Bank of Japan kept its policy unchanged. It will conduct money market operations so that the monetary base will increase at an annual pace of about 60-70 trillion JPY. The Bank continues to say that it will stick with its policy of Quantitative and Qualitative Easing (QQE) as long as it is necessary to lift inflation to 2% and keep it there.

Bank of Japan released "Outlook for Economic Activity and Prices". The forecast of this-year real GDP growth was slightly lowered. The central bank expects GDP growth at the level of 1.1% yoy in Fiscal Year 2014 (as compared to 1.4% in January). The bank said that downgrade in GDP forecast for this fiscal year is the result of delay in export recovery.

In the opinion of the monetary authorities Japan's economy will achieve growth above its potential on firm domestic demand and moderate rise in exports. The bank expects Japan's output gap to turn positive in latter half of fiscal 2014. The outlook for 2015 remained unchanged - GDP growth by 1.5%. The bank expects growth in real GDP for 2017 at the level of 1.3%.

Median forecasts of BoJ policy board members show they expect core CPI to be 1.3% in Fiscal Year 2014, 1.9% in Fiscal Year 2015 and 2.1% in 2016. Inflation forecasts for 2014 and 2015 did not change vs. the previous report from January. Thus, the central bank expects core consumer inflation to stay around 2% target for two years from fiscal 2015, signaling it sees no need to expand monetary stimulus for the time being.

Bank of Japan Governor Haruhiko Kuroda said that he would adjust policy without hesitation if risk factors were to lead to a change in the central bank's forecasts and pose an obstacle to meeting its price target. He added that it was too early to say when the central bank's quantitative and qualitative easing policy might be ended, after the bank issued inflation projections through the year to March 2017.

The increase in the national sales tax - to 8% from 5% - has sparked worries that consumers will curb their spending. The central bank, however, remains optimistic that the economy can withstand the pain without additional stimulus and sees a tightening job market leading to higher wages that will help accelerate inflation. Core consumer inflation in Tokyo, a leading indicator of national trends, jumped in April to a 22-year high of 2.7% in April in a sign that companies are making progress in passing on the tax increase to consumers.

The confidence about the prospects of hitting the inflation target in the statement makes it less likely that additional stimulus will come as early as July but we still cannot exclude further easing in October. Although, the JPY firmed slightly against the USD after the decision, in the medium term depreciation of the JPY is, in our opinion, still more probable scenario.